This blog is about macro-economics, financial markets and the world that has been pulled over your eyes to blind you from the truth.

— Neo: What truth?
— Morpheus: That you are a slave, Neo.

2010-12-17

Market sentiment: Equity Hedging Index is at a new record low

At the risk of repeating myself, December 2010 seems to be month when all the stars align, and bullishness is reaching historical extremes. This is the fourth market sentiment post this week and here's what we now have:

No New Normal Next Year Seen by Strategists Predicting 11% Gain in S&P 500

It's worth noting that the most recent reading of the Equity Hedging Index is at a new record low (data dates back to 2001). You can find more background on the indicator here. When we look at the various ways most speculators hedge against a decline, there is almost unanimous agreement among them. Each hedging component is scored from 0 (no hedging) to 100 (extreme hedging). Right now, three of them are at 0, three more are under 10 and one is at 36, giving us an overall average reading of 8. The previous record low was a reading of 9 on 12/23/04.

This Index takes into account the following ways that most speculators would hedge against a market decline:

Raise cash

Buy put options

Trade an inverse ETF or mutual fund

Sell short futures contracts

Buy credit default swaps

The Index looks at each of the measures above and compares current levels to historical averages. The more they show hedging behavior, the higher the EHI would go, and vice-versa.

When the EHI dropped below 20, during the next three months the maximum gain in the S&P 500 averaged +2.5% while the maximum decline averaged -5.9%. Each time, any short-term upside progress was erased during a swift corrective period at best.